Lightbulb blog on Business, IT and IP Law

Few businesses are as challenged currently by the online digital media revolution than the music business. This is an introductory post on the law, technology, hype and business models for music online.

Digital and online music is a market moving at warp speed through a cacophony of hype and spin. This post aims to provide a factual foothold for online business and intellectual property strategy decisions. Music's struggle also has lessons for other content licensing businesses which use digital rights management (DRM) systems and need to evolve their online business models.

The music business is at the forefront of change online, as it was with multimedia in the early 1990s. In both eras a key fact is that music's main "delivery platform" (ie CDs) was and is delivering content in a digital format.

IFPI global sales statistics as @ Aug. 2005

This simple fact puts the music business AHEAD or makes it MORE EXPOSED, it depends on your perspective. Behind it and less exposed in the transition from bits to bytes is the magazine, book, television, radio and film businesses, to name a few other businesses that live off content licensing, distribution and sale. But players in all those sectors can learn from music's struggle.

The patent law angle heightened last week in a case I have not as yet read. The notes on the case which follow are drawn from online magazines and online searches.

Last week a US federal court jury verdict in San Diego awarded Alcatel-LucentUS$1.52 billion in its MP3 patent suit against Microsoft . The two MP3 software patents were 5341457 for "Perceptual coding of audio signals" and E39080 for "Rate loop processor for perceptual encoder/decoder". The accompanying graphic is from those patents.

Wired News reported on 22 February that the damages award was based on this formula: [Windows Sales Volume After May 2003] x [Average Price of Windows Computer - about $1200] x 0.5% [the usual range is 0.5% to 3%].

Microsoft chose to move away from pure MP3 for its own proprietary Windows Media format. However it apparently used two patents claimed by Alcatel-Lucent. They were developed at Bell Laboratories which became part of Lucent Technologies and Alcatel bought Lucent in 2006 thus inherited the patents. Alcatel-Lucent sued Microsoft over audio-file technology first included in its Windows operating system in 1998 and later built into its Windows Media Player.

In response to the jury verdict, Microsoft issued a short press release in which Tom Burt, Microsoft Corporate Vice President and Deputy General Counsel said in part:

"We think this verdict is completely unsupported by the law or the facts. We will seek relief from the trial court, and if necessary appeal. Like hundreds of other companies large and small, we believe that we properly licensed MP3 technology from its industry recognised licensor - Fraunhofer. The damages award seems particularly outrageous when you consider we paid Fraunhofer only US$16 to license this technology."

[Update, August 2007]

The above judgement was reversed on 4 August 2007. U.S. District Judge Rudi M. Brewster for the Southern District of California overturned the $1.5 billion jury verdict against Microsoft.

Judge Brewster found that one of the two patents was not infringed and the ownership of the second patent was questionable, and a new trial may be needed to determine who owns it. Judge Brewster ordered a new trial on the damages because he said the jury erred when it awarded damages and royalties using a formula based on the number of Windows-based computers Microsoft sold during the period of alleged infringements. Manufacturers of MP3-related products currently then have a lower chance of facing a similar suit from Alcatel-Lucent.

2. Pipe dreams

For now the patent damages verdict against Microsoft is a fact. It should be weighed on a scale against the lightweight, ill-informed and hype-style commentary on digital rights management (DRM) as applied to music or audio files.

That commentary rose to a crescendo in recent weeks and has great populist appeal.

But the misguided mantra running along the backbone of those raves is generally this - that getting rid of DRM will automatically introduce a Nirvana of ongoing free and unfettered MP3 or other audio music files. I say "dream on...".

If informed strategy development is your bag then you might start by reading this recent InfoWorld news item about litigation launched on 16 February 2007 in Texas against Apple, Samsung Electronics and Sandisk.

iTunes store - uses ACC format DRM

DRM is an umbrella term. In the context of music it includes devices, products and components which prevent unauthorised access to copyright materials. They include encryption, access codes, copy protection systems, broadcast flags, and watermarking. They are mechanisms to restrict IP piracy and unauthorised copying.

Yes, DRM in the form, for example, of iPod's FairPlay annoys a lot of people. We'd all like a free lunch, right?

Yes, it's a pain that you can't shift recorded material between platforms with ease, eg from iPod's FairPlay to Microsoft's PlayForSure, to ReaNetwork's Helix-DRM and to Sony's flavour of DRM.

Consumers would love such interoperability. It can also benefit industry providers. But to get there involves implementation of strategic decisions which have huge financial or industry restructuring consequences. This brings us to the issue of online business models.

3. Online business models

Format lock-ups and format wars are par-for-the-course in the century-old history of proprietary recorded music formats and the technical and legal regimes used to lock-in or lock-out users of content and software of all sorts. For music formats I wrote the recent post Music formats and law: commercialisation of 45-rpm records.

The real issue is that the fact that music works fine for most people in the MP3 digital file mode has resulted in consumer perceptions as regards value. Consumers now perceive CDs as being overpriced. iTunes and other similar services have made the price of CDs look expensive. This has put the music business into a public relations and market erosion slide from which it needs to find a way out. Following are bullet points, illustrating very briefly the the jungle out there involving publishers, hardware vendors, hackers and online music retailers.

The major five music companies - BMG, EMI Group, Sony, Universal Music Group, and Warner Brothers Records - are all exposed.

According to IBISWorld figures in Australia the sale of compact discs have not grown over the five years to 2006. Also according to IBISWorld in 2006 there was a A$30 million market in Australia for digital downloads, a figure it said will almost double in 2007.

According to figures from the International Federation of the Phonographic Industry (IFPI) global digital music sales doubled in 2006 to an estimated US$2 billion. It was also a year in which the number of legally available digital tracks also doubled. Further, distribution channels for them increased (eg iTunes stores and Destra in Australia). By late 2006 there were 500 online music services operating in 40 countries. At the same time, IFPI claims "some 10,000 [legal actions against large-scale P2P uploaders] were announced in 18 countries in 2006...".

There's no magic bullet for digital piracy or unauthorised copying. DRM systems for Blu-ray and HD DVD have already been cracked by "muslix64" according to news reports this month.

Steve Jobs has talked up Apple, Inc's position with an open letter titled "Thoughts on Music". In 2006 the British Phonographic Institute (the British record industry's trade association) urged Apple to make its FairPlay DRM compatible with other players.

France, Germany, Norway and some other Scandinavian countries are on what has been described as an anti-iTunes campaign seeking interoperability. They are apparently pondering possible new laws to unlock iTunes in their territory.

Norwegian Jon Lech Johansen, who achieved notoriety in 1999 for cracking the copy protection of DVDs, said in October 2006 that he has cracked the iPod's FairPlay and set up a new business in San Francisco, called Double-Twist Ventures.

Destra, Amazon, Limewire, MySpace, eMusic and Yahoo! Music have all made sounds that they'd like to retail more music, typically provided it is in a DRM-free MP3 format.

4. The legal environment: Australian copyright law

As always, changes in technology and business models will force changes in copyright law. But copyright law is not going to change for some time to come. The cases and law are continuing their trend in recent years towards more protection for copyright owners.

To illustrate that, following are references to one recetn court case, recent amendments to the Copyright Act and the Free Trade Agreement's requirement for laws against anti-circumvention of "technology protection measures" (read DRM).

The Australian Copyright Act 1968 (Cth) was recently applied in the music and MP3 context in the Australian Full Federal Court on 18 December 2006, when on appeal the Court found against a file-sharing website, MP3s4FREE.com, an ISP and their respective company directors. The case is Cooper v Universal Music Australia Pty Ltd. It applied the long-standing section 101 of the Act and several cases against those who authorize the breach of copyright. Protection sought under section 112E was held to be not available on the facts. The ISP's employee's appeal was allowed on the basis of a lack of evidence that he had power to prevent Mr Cooper's conduct.

Copyright law was recently bolstered considerably in favour of copyright owners (with the effect of benefiting music publishers and owners of DRM systems.)

In the legal context of the Australian Copyright Act 1968 (Cth), following copyright laws introduced late in 2006, DRM falls within the term "technological protection measure" (TPM). Under the Act there are civil remedies and criminal offences for circumventing TPMs. The TPM provisions are very tightly worded as are the exceptions that can apply.

Australia's Free Trade Agreement with the US came into force on 1 January 2005 and because of IP requirements in it Australian and US laws against anti-circumvention of TPMs are not going to go away real soon.

In simple language, the law is that if a copyright work has a lock on it breaking it constitutes a breach of copyright in Australia, the US and several other jurisdictions. Criminal penalties include five years imprisonment and/or fines of $60,500. Publishers, distributors and organisations such as - Australian Federation Against Copyright Theft [Update: renamed Australian Screen Association) and Music Industry Piracy Investigations (Update: renamed Music Rights Australia) - will be looking to use these new powers in prosecution action.

5. The technological environment

I said at the outset that this post is an introductory note to create a factual foothold for the debate regarding online music, DRM and MP3s.

It is appropriate then to end with a table of notes overviewing legal and operational aspects of MP3s, MP3 players, DRM and iPods. They are largely drawn from Wikipedia. The aim is to have condensed facts to improve our understanding of business strategy decisions as they emerge affecting the online music, DRM and "free" MP3s debate. This also helps players in other sectors learn from music's struggle.

MP3 - digital music

MP3 technology was first developed by a team of German engineers (as part of an EU-funded project) who worked in the framework of the European Union financed EUREKA digital radio research program from 1987 to 1994. For the casual listener the difference between the audio quality of a CD versus MP3 is not great.

The lack of DRM restrictions makes MP3 files easy to edit, copy and distribute over networks.

MPEG 1 layer 3 (shortened in general use to MP3) is a standard of the Moving Picture Experts Group (MPEG), part of the International Standards Organisation.

The popularity of MP3s grew with the successes of companies and software packages like Nullsoft's Winamp (released in 1997), mpg123, and Napster (released in 1999). They made it easier for the average user to playback, create, share, and collect MP3s.

Thomson Consumer Electronics, a San Diego firm which says it represents Germany's Fraunhofer Society, controls licensing of the MPEG-1/2 Layer 3 patents in many countries, including the United States, Japan, Canada and EU countries.

About 400 companies, including some of the world's largest technology companies, have licensed MP3 technology from it. Thomson has the rights to 20 families of patents that cover some of the standards for compressed audio files and are essential to implementing MP3 technology.

For current information about its patent portfolio, licensing terms and fees go to mp3licensing.com. MP3 licence revenues generated ca. 100 million euro revenue to the Fraunhofer Society in 2005.

Digital Audio Players (AKA MP3 Players)

In 2000 iRiver released the first digital audio device, more popularly known as an MP3 player. The first iPod appeared in 2001.

The MP3 players come in two types.

Solid state players are durable, eg for use in jogging. Examples include the iPod nano, Creative MuVo Micro and the iRiver T series.

Hard drive players are heavier and bulkier and capable of holding more music. Examples include the iPod video, Creative Zen series, iRiver H series and Toshiba Gigabeat.

iPod - portable media player

Apple Computer's iPod was unveiled in October 2001. There are many collaborators and inventors behind the iPod. One is Synaptics which partnered with Apple to develop the scroll wheel designed by Apple.

There have also been a line of law suits. They include patent cases from Advanced Audio Devices claimed breach of its "music jukebox" patent and Pat-Rights claim that Apple's FairPlay was in breach. FairPlay is a DRM system which encrypts the iPod's AAC audio files.

The iTunes Music Store was introduced in April 2003. It has boosted the legal music download business. No music player other than the iPod can play the FairPlay-encrypted files sold on iTunes.

The vertical monopoly nature of the iPod, iTunes and FairPlay technology system is bolstered by the fact that the iPod cannot play files protected with other digital rights management technologies, such as Microsoft's DRM format or ReaNetwork's Helix-DRM system.